Government Report Reviews Private Student Loans and Recommends Statutory Changes

The Consumer Financial Protection Bureau (CFPB) and the US Department of Education released a report to Congress about private student loans on July 20, 2012 as mandated by section 1077 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203, 7/21/2010). The report discusses the growth and changes in the private student loan marketplace, the use of private student loans by students and their parents, the characteristics of private student loan borrowers and lenders, the credit underwriting criteria used by private student loan lenders, the consumer protections for borrowers and lender compliance with fair lending laws. The report also makes recommendations for improving consumer protections.

$150 Billion in Private Student Loans

Based on data from nine large lenders of private student loans, the federal agencies report that total student loan debt outstanding reached $1 trillion in late 2011. Of the total, $864 billion is from federal education loans and $150 billion is from private student loans. $8.1 billion in private student loans, about 5.4% of the total, is in default. Less than 15% of outstanding student loan debt is from private student loans. Less than 7% of new loan volume in 2010-11 was from private student loans. As noted by US Secretary of Education Arne Duncan, borrowing to pay for college may previously have been the exception, but now it is the rule. The nine lenders who supplied data for the report are Citizens Bank, Discover Financial, First Marblehead, JP Morgan Chase, PNC Bank, Sallie Mae, SunTrust Bank, US Bank and Wells Fargo. These lenders account for about $140 billion of the private student loan debt outstanding. The rest is from smaller lenders as well as institutional and state loan programs.

Characteristics of Private Student Loans

The report provides many statistics about the characteristics of private student loans. The current average interest rate on the private student loans in the sample portfolio is 7.8%. Variable interest rates as of December 2011 ranged from 2.98% to 19.0%. Fixed interest rates ranged from 3.4% to 13.99%. Starting in 2007-08, the minimum initial interest rate on private student loans dropped significantly as compared with the average initial rate and the maximum initial rate. This suggests that lenders reduced the initial rate, which is received by a very small percentage of borrowers, as a loss leader to reduce the best advertised rates on their loans. Credit underwriting criteria, such as minimum credit scores and cosigner rates, have tightened significantly since the start of the credit crisis. The 25th percentile FICO score, for example, increased from 599 in mid-2007 to 653 in mid-2009. This indicates that lenders reduced lending to the least creditworthy borrowers in the aftermath of the subprime mortgage credit crisis. Cosigner rates also increased. In 2005 about 55% of private student loans had cosigners. This increased to 67% in 2008, 85% in 2009 and more than 90% in 2011. The cosigner rates increased for all types of loans, including loans to undergraduate, graduate and professional school students, but the sharpest increase was for students in medical school and law school. School certification, however, went down and up. There are two main types of private student loans. School certified loans require the college financial aid office to certify that the student is enrolled and to approve of the loan and the loan amount. Direct-to-Consumer (DTC) loans bypass the college's financial aid office and present the lender with a higher fraud risk, but are also more popular with consumers. Borrowers of DTC loans are more likely to overborrow and the credit quality is inferior to that of school-certified loans. In 2005 about 60% of private student loans were school certified. This dipped to about 28% in 2008 and increased to 90% in 2011.